The Irony Of The Euro Crisis: This Is What The World Would Be Like Under The Gold Standard

I’ve spent a great deal of time in the last few months describing
why the Greek crisis was much larger, more complex and a greater
risk than anyone assumed. As stocks continued to chug higher
(and I built short positions) an odd
occurrence was brewing. Gold prices were rallying in tandem with
the dollar. As the market began to crater and eventually crash
1,000 points in one day the gold market actually continued to
rally along with the dollar! For anyone familiar with gold and
forex markets this was more than odd. But there is a reasonable
explanation for the move. And half of that move is entirely
unjustified and incorrect in my opinion.

What if I told you that the Euro’s inevitable demise was
not a condemnation of fiat money? You’d probably
call me crazy. Well, that’s basically what several emailers have
done in recent days. I received this friendly note from a reader
recently:

“nice work predicting the risk in Greece and the Euro over the
last few months, but you’re dead wrong about paper money and the
gold standard. The Euro is proving that paper money does not work
and gold’s recent price increases prove that the move towards a
gold standard is on the horizon”

The irony behind the Euro crisis is that it is not at all a
condemnation of fiat money. In fact, it is a condemnation on
single currency systems such as the gold standard. I have long
argued that the mess the EMU created in 1999 with the inception
of the Euro was unlikely to survive a serious global recession.
This was due to one primary argument. The gold standard and
single currency systems have all ended in demise for similar
reasons. This was due to their inherent inflexibility and
inherent weaknesses imposed on particular trade partners within
the currency system. As I’ve previously noted in “Reflections on gold as an asset class“:

“the gold standard had a tendency to cause severe strains on
countries due to trade imbalances and the inability to provide
flexibility to countries with trade deficits.”

The move off the gold standard and convertible currency systems
has generally been due to the inherent restraints imposed by such
systems. For instance, trade deficit nations are at an inherent
weakness when attempting to respond to recession because the
trade imbalance results in rising unemployment and falling output
and prices – an inherently deflationary environment. With your
own currency this imbalance would naturally offset over time, but
under a single currency system there is no opportunity for the
floating exchange system to reach balance. This is just one very
simple example of the types of inherent restrictions a single
currency system imposes on a nation, but it’s particularly
pertinent as we see this exact event unfolding in Greece – where
the single currency system is destroying the country and
handcuffing the government from properly defending their economy
and thus providing for their citizens. Instead, they are risking
default (a risk which does not exist within a sovereign issuing
floating exchange system) and forcing their citizens into
recession all so the surplus nation of Germany can enjoy price
stability and continued high exports.

The inefficient market irony within all of this is that the
markets are viewing the Euro crisis as a condemnation and failure
of fiat money. That couldn’t be farther from the truth. What we
are seeing in Europe is in many ways what we would see if the
world were living in a gold standard world or a convertible
currency world. The same unnecessary restrictions would occur and
deficit nations would be at risk of recession which would
ultimately result in regional and perhaps global recession. The
recent rise in gold prices is not based on the true fundamentals
of mined gold, but rather on the hope that the Euro’s failure
will increase demand for gold via its potential return as a true
currency. As we’ve described above, that is entirely misguided
thinking and perhaps the greatest real-time example of the
inefficient market I have ever witnessed.

Of course, this doesn’t imply that gold prices are set to
collapse. In fact, we are likely to see gold prices continue
their record move so long as the weakness in the Euro continues.
If the Euro collapses misguided governments will clamor for gold
as they incorrectly worry over the stability of their own paper
currencies. After all, the ignorance with regards to our monetary
system extends up to the very highest levels of government and
the total lack of understanding is on display in Europe every day
as politicians make mistake after mistake and further destroy
their economy. The politicians and central bankers have
mishandled this crisis at almost every single step and this lack
of understanding with regards to the monetary system is the
single largest contributing factor. What does this all prove?
The inefficient market is alive and well.